Economic Logic, Too

About Me

I discuss recent research in Economics and various events from an economic perspective, as the name of the blog indicates. I plan on adding posts approximately every workday, with some exceptions, for example when I travel.

Friday, July 30, 2010

The economics profession is being criticized these days because it was unprepared for the recent crisis. Few people had thought about the fact that liquidity problems of such dimensions could appear in interbank markets. Thus it is now very welcome to think about hypothetical situations instead of studying past phenomena. One such hypothetical is what to do if North Korea would suddenly abandon its Juche system (self-reliance).

Scott Bradford, Dong-jin Kim and Kerk Phillips tackle this with a simulated dynamic general equilibrium model, pretty much the only solution given that there is no history to draw on and no reliable data. Also, this is definitely a situation where reduced forms would not teach us anything. So, structural they go. First, they try to emulate the current situation with massive mis-allocation of resources and little infrastructure. It is quite obvious that from this starting point almost any reform is beneficial. But suppose the reform is purely internal: no opening of the economy, and no touching the military. Then introducing market forces, but this still be of limited extend given the immense lack of infrastructure, Massive investment in infrastructure is needed much more urgently than market reform. And serious commitment to reform that would benefit residents is likely to attract significant foreign aid, which makes it much more affordable.

Thursday, July 29, 2010

There is a literature that tries to understand bequests, in particular whether they are accidental or voluntary. This is an important question as it has strong implications on savings motives, and thus on aggregate savings. With the development and sophistication of financial markets, one should see the accidental bequest to become less important. People can insure themselves against uncertain life times with annuities and life insurance, thus reducing the need to have excess savings in the case of unexpectedly long life. Voluntary bequests may go either way with development, depending on whether parents prefer to make inter-vivos transfers, which they can afford given the above.

Now all this is put into question after a great data digging initiative byThomas Piketty, who compiled bequest data for France from 1850 to 2008. He notices that while the size of bequests has decreased until the 1950s, this trend is now reversed. Concretely, as a fraction of national income, bequests amounted to 25% in the late 1800s, 5% in 1950 and 15% nowadays. Piketty measures this in two ways, once using wealth data and mortality tables, and once using actual bequests as recorded by fiscal authorities. The second measure is somewhat lower, as expected, but shows the same pattern through time.

The important question is now, what is the new incentive that would make households to leave larger bequests now (and even more in the future, as Piketty suggests)? The old argument of the new growth regime that came with Industrialization is clearly not valid. Piketty proposes that the difference between the rate of return and the growth rate mostly drives the aggregate size of inheritances. But there surely are also important microeconomic aspects, like the wealth distribution, borrowing constraints, the correlation of income between generations and subtleties of the tax code.

Wednesday, July 28, 2010

It seems quite obvious that the United States will have to increase energy taxes, first because energy prices need to better reflect the negative externalities they exert on the economy (pollution, wars, congestion, etc.), and second because the government will need to raise revenue from somewhere. So it is of particular interest to verify what consequence this would have, for example on labor markets. If the cost of an input increases, and it is cheaper elsewhere (or if not, the gap with elsewhere is reduced), one should expect labor demand to be reduced. But how much?

Olivier Deschenes does such an empirical exercise by exploiting the cross-state variation in energy prices and finds a price elasticity of 0.15. Given that the electricity prices are supposed to rise by 4%, a reduction in employment of 0.6% or 460,000 people is inferred. Unfortunately, these estimates cannot be relied on for several reasons. First, estimates are based on employment differences across states due to energy price differences. Imagine that electricity prices increase in Michigan, and this drives some jobs to Wisconsin. This is what this elasticity measures. But when electricity prices increases in all states, cross-state movements of jobs should not happen. They may move abroad, but this is not measured with this procedure, which certainly overestimates the correct elasticity.

Second, these are reduced form estimates that give us very little understanding how various agents in the economy would react to those price changes, especially if they are larger that the one observed in the data. One needs here some structural model to understand what would happen, a model that would, for example, include the industrial structure of each state. Computable general equilibrium (CGE) models have been used extensively for similar exercises, and should be much more reliable than this reduced form (Lucas Critique anyone?). Third, if you do not increase energy prices, it is quite obvious that some other tax will have to increase. An obvious candidate is labor income tax. Now that is certainly going to reduce employment as well, and possibly more than the 0.6% from above. In other words, the energy tax can very well be a lesser evil (on top of reducing pollution).

Some press will pick up this paper and rail against energy taxes. That is most unfortunate.

Tuesday, July 27, 2010

To finance public goods, taxes need to be levied. But with globalization and international tax competition, the ability of governments to levy taxes is curtailed. Indeed, raising taxes may increase the cost of labor compared to other locations, and outsourcing takes over. The same reasoning applies to other taxes, which become more distortionary with globalization. Of course, it is never bad to put some pressure on governments to keep taxes as low as possible and thus remain efficient, but one may hit a feasibility constraint here.

Torben Andersen and Allan Sørensen think we should not worry too much, though. First, one consequence of globalization is that increased trade leads to a lower cost of goods. This decreases the marginal cost of public funds. Second, there is not necessarily a race to the bottom among tax authorities because terms of trade work to counteract the after-tax disadvantage of higher taxes, apparently for a wide set of parameter values. In other words, gains from trade and general equilibrium effects can absorb the increased distortions from taxes.

Monday, July 26, 2010

Immigrants are often held responsible for increased crime rates, or crime in general. As these accusations occur in every country one has to wonder whether people immigrate because they are criminal, yet immigration authorities typically vet criminal records. So are immigrants really more criminally inclined than native populations? A recent paper should help shed some light.

Brian Bell, Stephen Machin and Francesco Fasani look at two recent immigration waves to the United Kingdom and find no difference between natives and immigrants. Specifically, they look at the surge of asylum seekers in the 1990s and the large influx of Eastern Europeans in 2004. They key is that immigrants have different demographic and labor market characteristics than natives. Once you control for this, there is no discernible difference. This means also that providing better work perspectives to immigrants reduces both their crime and victimization rates, as it is the case for locals. In particular, forbidding asylum seekers to hold a job seems counterproductive.

Thursday, July 22, 2010

The standard endogenous growth model assumes that markets are perfectly competitive, and thus factors are paid at their marginal product, and Cobb-Douglas production function parameters corresponds to factor income shares. But looking at the real world, there clearly are economies where "capitalists" or "unions" have more bargaining power. Beyond the semantics, is there something to gain from imperfect competition on factor markets

Christopher Tsoukis and Frédéric Tournemaine take a fairly standard AK model, except that they impose that workers not only derive utility form their consumption, but also from capitalists getting less consumption. Then they look at four different equilibria: perfect competition, Stackelberg, Nash and non-cooperative. They show that the resulting factor shares and growth rates differ across equilibria, Labor income shares are lowest in the competitive equilibrium, highest with Stackelberg, and the opposite for growth rates. Unfortunately, no attempt is done to relate this to any data. This would have been probably very difficult anyway. Indeed, labor income shares vary surprisingly little across economies, with only one outlier: China, with a very low labor income share, opposite the prediction of the model.

Even worse, the paper concludes with some major hand waving finding some conclusions about inflation and unemployment, in a model without money and an inelastic labor supply. Too bad.

Wednesday, July 21, 2010

Purchasing power parity (PPP) implies that adjusted for exchange rates, similar goods should have the same price across countries. However, this does not hold true, and for extended periods. Why this happens is a puzzle, which is even more confounding considering that deviations from aggregate PPP have a longer half-life than deviations from good-level PPP. Jean Imbs, Haroon Mumtaz, Morten Ravn and Hélène Rey have claimed that this apparent micro-macro disconnect can be explained by a composition effect.

Not so fast, say Paul Bergin, Reuven Glick and Jyh-Lin Wu. Their point is that macro- and micro-PPP follow different processes, the first following aggregate shocks and the second mostly relative-price shocks. Using a vector error correction model, which controls for these shocks, they show then that the remaining deviations are consistent between macro and micro data and have very similar half-lives. This means that the previous explanation based on the heterogeneity of goods and different price stickiness does not hold water. Back to the drawing board...

Tuesday, July 20, 2010

Unemployed workers who stay unemployed for a long time are a cost to society, because they receive unemployment insurance and other social benefits, and because their human capital depreciates and they will thus less be able to contribute in the future. That does not preclude unemployment insurance from being useful, it should just not be used more than necessary. How could this be guaranteed? There is plenty of literature about the optimal design of unemployment insurance, but this helps little when unemployed workers face concrete hurdles to returning to work.

Ulrika Vikman looks at Sweden where some unemployed workers are eligible for free childcare conditionally on returning to work. While the probability of transitioning to a job is unaffected for men, it definitely works for women, especially if they have two children. Clearly, offering these services lowers significantly the reservation wage for mothers. By how much would give an interesting insight how mothers value childcare, unfortunately the data used here does not include wages.

Monday, July 19, 2010

There are a lot of notions floating among education professionals that are actually wrong, and this has done a lot of harm as to how policies are set and how budgets are spent. The prime examples are that every classroom needs a computer, that smaller class sizes are better, or that the poor benefit more than the rich from subsidized college education. In the latter case, the underlying issue is that rich kids tend to get education for a much longer time than poor ones, and thus they benefit more from the subsidy, even after accounting for the taxes their parents pay. But would free college tuition at least enhance the accessibility of college for poor families.

Not even, claims Kevin Denny, who uses a natural experiment in Ireland, where university tuition was abolished in 1996. The explicit goal of the policy was to create more equality in access to university. Its consequence, though, to remove the small advantage lower incomes had, as they enjoyed asset-tested education grants that were abolished. In other words, the big winner was the middle class. The real equality of access problem originates much earlier than at entry into university. Lower class children have much weaker achievements in school, They need support all the way to pre-school, not university.

Saturday, July 17, 2010

Why do people have this fascination with lawns? They are fundamentally useless and people devote large resources to it. Thinking about it, it is even absurd. You devote resources to remove naturally growing plants, pay for new seeds, then pay for fertilizer and devote resources to watering regularly so that the lawn grows well. Then you spend time or hire people to cut it short! And you just trash what you cut!

And do not tell me a lawn looks nice. I much prefer wild grass with wild flowers. Or that a lawn is useful, as it usually cannot not sustain much foot traffic on it. That space would be more useful if something were cultivated for consumption, or if it had some sheep or goats on it. And because the lawn needs to be perfect, leaves need to be picked up in the fall. Another useless effort.

Friday, July 16, 2010

In many countries, the movement towards charging for plastic bags appears to be a major annoyance for consumers used to free bags (and double-bagging). In most cases, retailers are forced to charge for the bags, in some few cases, they are taxed on them: Ireland, Denmark, South Africa and Botswana. Yes, Botswana, where retailers are free to pass on the tax to customers, and most do. Botswana also imposed that bags cannot be too thin, which avoids single use and wasteful double-bagging.

Johane Dikgang and Martine Visser study the consequences of these plastic bag taxes in Botswana find a very large response: the number of bags used halved within 18 months, with half of this change happening within the first weeks. Interestingly, the sharpest reduction happened at the bottom end retailers, and also at the top end retailers. While at the bottom a bag became a measurable share of the shopping bill, and hence could easily be saved, that is certainly not the case at the top end, where prices are higher and quantities shopped in a trip a larger. I wonder whether, in the case of high-income households, it was not so much the price of the bag that mattered, but rather that it signaled that bags are bad and one should reduce their consumption.

Thursday, July 15, 2010

Alcohol use has an impact on crime in many ways. Perpetrators maybe mentally impaired by alcohol abuse, may be motivated by an addiction, or venues were alcohol is consumed may give opportunities for crime. Also, being a consumer of alcohol may increase the likelihood of victimization. What economic policy means are available to reduce crime from alcohol use? Obviously, you want to reduce alcohol use and abuse, but let us for once leave the health consequences aside (assume they are already internalized by the consumer).

Christopher Carpenter and Carlos Dobkin perform a meta-analysis of the literature and find that taxing alcohol and putting age limits to its consumption are the best policies. Restricting when or where alcohol can be consumed has, however, little impact on alcohol-related crime.

Beyond what the literature says, I have always been puzzled how different cultures deal differently with alcohol. For example, Italians drink wine already as kids, yet you rarely find drunken Italians. In fact, the only drunks I have encountered in Italy where American students and British tourists. My anecdotal evidence is that the more regulated alcohol consumption is, the more people are drunk. But the causality may very well run the other way. For the current paper, though, what really matters is how alcohol consumption translates into criminal behavior. And the literature seems here counter-intuitive to me.

Wednesday, July 14, 2010

What triggered the Industrial Revolution has been the subject of debates for decades. While currently the emphasis is on the Unified Growth Theory, other interesting explanations exist. One of them is by Deirdre McCloskey, who claims that the wide adoption of Bourgeois values was critical. By that, she means that once innovators and capitalists were looked up to or were considered gentlemen, an economic transformation towards industrialization could happen.

Are there some lessons to be learned for the current economic situation? Gustavo Morles thinks that we are currently witnessing a loss of Bourgeois values, particularly in Europe where welfare states are strong and demographic shrinkage attracts people with different values. The United States are not immune, as shown by the election of Barack Obama. The consequences would be a prolonged economic crisis due, presumably, to disappearing entrepreneurship.

While there is indeed worldwide more anti-business and pro-regulation rhetoric than for a long time, I think it is too early to call this a permanent change in attitudes. And in an era so dominated by fads fed by the media, this may change as fast as it arose.

Tuesday, July 13, 2010

The current recession has certainly increased the academic interest in business cycles, their origin and their cures, if any. Many prominent economists ventured outside their traditional field of research to weigh in, most prominently Paul Krugman, a trade theorist. Add now Vernon Smith, an experimentalist and also a Nobel Prize winner, to the mix.

Steven Gjerstad and Vernon Smith do an exercise that is very reminiscent of Burns and Mitchell: a graphical analysis of various recessions to determine their dynamics. They conclude that various types of investment fluctuate the most, that residential investment leads the cycle, while business investment lags it. In other words, they have discovered some of the stylized facts that have been driving business cycle research of the last decades. This is their third paper on the topic, I am sure there will be more.

Friday, July 9, 2010

Academics, at least in Economics, have been largely dysfunctional in Italy for a long time. With faculty positions centrally administrated by the Ministry of Education, competitions rigged against people coming from abroad, and newcomers have first to pay their time in the purgatory (the South or the islands), there have been very few incentives for quality people to stay or return to the country. Hence a very large diaspora of Italian economists throughout the world who even have organized themselves into a separate society to try to shake things up. Things have moved, a little bit, as universities have now more autonomy in hiring, and one can wonder whether this has done any good.

Adriano Birolo and Annalisa Rosselli provide an assessment of the quality of new hires into entry-level positions around 1985, 1995 and 2005. While the number of hires seems to have substantially increased, their quality does not seem to have. While they may publish more, they do so with substantially more co-authors. where there seems to be some change is in the topics of research. Italy has always had a very strong tradition in the history of economic thought, indeed a sixth of all publications were devoted to this in the 1980s, and this emphasis seems to dwindle to the advantage of Microeconomics, which was virtually absent. So at least in terms of research topics, Italy is becoming less of an oddball.

Thursday, July 8, 2010

Pension funds, life and health insurance companies suffer from a substantial long-term risk: What if their members live longer that expected? While they tend to work with actuarial tables to set premiums and benefits, those tables a re backward-looking, and to price things correctly, the insurers need to make accurate projections about future demographics. But if there is risk, there should be a way to insure oneself against it if a counter-party is willing to take that risk.

David Blake, Tom Boardman and Andrew Cairns make the case that insurance companies should be putting longevity bonds on the market, whose payouts are tied to the demographics of a particular cohort. Imagine an insurance company is selling annuities, but medical developments let some cohorts live unexpectedly longer. By reducing payouts on those cohorts' longevity bonds, the company can finance the shortfall. The question is then who is willing to buy those bonds. Certainly not the cohorts in question. They have annuities already, and those who do not would want a higher payout, not a lower one. Pharmaceutical companies are good candidates, as they face an inverse risk: if a cohort lives shorted than expected, the return from many drugs suffers. But is this enough?

Wednesday, July 7, 2010

Gary Becker's theory of the family has had a tremendous impact on the understanding of marriage, yet it does not explain everything. This has been attributed, for example, to the fact that there is an element of randomness (irrationality?) in marriage. But adding randomness is not sufficient. For example, one predition of the model is that as female labor participation increases, the divorce rate increases because marriage conditions have changed. But now that female labor force participation has stabilized for about a generation, i.e. it is in a steady state, the divorce rate should go back down. Yet it remained high. What about going beyond Economics and using some insights from Sociology?

Take Signe Hald Andersen and Lars Gårn Hansen, who assume that marriage does not only happen on productivity matches but also on partner specialization matches. By that they mean that like-minded people, especially with respect to female labor market participation, divorce less. But this is not sufficient: such matching is subconscious, it does not follow a rational decision, but it is consistent with it. Concretely, this means that people match on these preferences without knowing it, and when conditions change (female wages rise), divorce rates increase, but less than without partner specialization matches, and do not have to decrease. The authors then demonstrate this with an agent based model.

Tuesday, July 6, 2010

As a teacher, who has not faced this dilemma: you want your students to make an effort and learn, but you also want them rewarded with good grades so that they do well on the job market or with college applications. If your grading practices cannot be observed by outsiders, there is no reason for you to give bad grades, and students will not study hard.

Robertas Zubrickas rationalizes all this with a principal-agent model where the teacher cares more about the learning and the students more about the signaling. Teachers offer a contract to students, oberserving perfectly their performance and rewarding it with good grades. The problem is that issuing good grades is costless. Of course, what really matters are relative grades, but if the market cannot observe the grading rule or the grade distribution, all that matters are the "nominal" grades. The result: everyone gets the best grade, and there is complete pooling. And it is empirically observed that schools with laxer grading standards achieve lower SAT scores.

And how can one prevent this poor outcome. Either make the distribution of grades available, thus making grades "real" instead of "nominal." Or make it costly for teachers to give good grades (instead of making it costly to give bad grades by asking for extra administrative steps for those). For example by imposing a distribution or an average grade. I would certainly welcome this, as some of my colleague are clearly free-riding and giving good grades to everyone.

Monday, July 5, 2010

Much of Economics is based on the premise that property rights are well established, in particular that contracts are either enforced, or self-enforcing. But what if you have to deal with agents with no respect for property and armed with mallets?

Harold Houba and Hans-Peter Weikard describe what they term a "stone age equilibrium." It emerges when exchanges can be coercive, but also voluntary and is thus and intermediate between the Walrasian equilibrium (purely voluntary) and the "jungle equilibrium" of Piccione and Rubinstein (purely coercive). In a stone age equilibrium, no one prefers to take from a weaker agents, and there are no bilateral gains from trade. Interestingly, such an equilibrium can feature gifts and withholding goods. In other words, pretty much anything can happen. Required reading for all doomsday sayers and survivalists.

Friday, July 2, 2010

Why do some countries, in particular developed one, engage more in environmental protection than others? The traditional answer is that higher incomes and long life expectancy allows people to value more their surroundings and the future. However, rich people or countries may engage in alleviating the consequences of a poor environment instead of contributing to a better one. For example, similarly rich countries have very different track records. Thus there must be something else that distinguishes them.

Natacha Raffin builds on the evidence that US states where higher proportion of the population holds a high school degree also are more environmentally aware, even after controlling for income. In other words education matters. But education policy is endogenous, and one needs to determine what makes a state choose to educate more its citizens on environmental issues. Say you expect poor environmental conditions, and thus shorter life expectancy. Then it is less worth investing in human capital, and the circle is complete. And the beliefs are more positive, they are also self-fulfilling. We thus have multiple equilibria. This can also explain the frustration that pro- and anti-green camps have with each other.

Thursday, July 1, 2010

The analysis of fiction or fictional worlds from an economic point of view is an interesting "hobby" of some economists, from the Economics of Harry Potter, World of Warcraft to CSI: Crime Scene Investigation. There appears to be also a stream of research dealing with operas, and in particular Wagner's, which are full of intrigues, hard decisions and conflicting beliefs.

Ilias Chrissochoidis and Steffen Huck look at Lohengrin. The story is about whom to believe, commitment, signaling, normal form games, Bayesian updating, and asymmetric information. I need to listen again to Lohengrin, which I have not touched in decades. Maybe I will hear it with a new ear now that I can recognize all the Economics in it. This paper is totally useless for policy, yet fascinating.